T. Rowe Price Real Estate fund isn't all it's cracked up to be

With the market in a frenzy, investors are looking for alternatives to stocks and bonds. They may not be ready to go the route of classic cars as hyped on television last week by CNBC, but they can get pretty comfortable with an old stand-by: Real estate.

So if an average investor decides to pursue a real-estate mutual fund, they’ll look for a few characteristics, like top marks for consistent return from Lipper, an analyst’s recommendation from Morningstar, and top-shelf performance over the long haul.

That kind of research might well bring them to T. Rowe Price Real Estate (TRREX), which on the surface has everything going for it. Dig a little deeper, however, and it appears that average investors haven’t gotten what they wanted from the fund, and that crucial disconnect makes it the Stupid Investment of the Week.

Stupid Investment of the Week highlights the concerns and conditions that make a security less than ideal for the average investor, and is written in the hope that spotlighting trouble in one case will make it easy to avoid danger elsewhere.

While obviously not a purchase recommendation, neither is the column intended as an automatic sell signal, as there are times when dumping a worrisome investment actually compounds the problems.

That could definitely be the case with T. Rowe Price Real Estate because, by most metrics, the fund has been a big winner. If you are one of the investors who has won with it, hanging on for the long run makes perfect sense.

But indications are that the fund has been a winner, but investors who went there haven’t been.

Consider this: Over the last 10 full calendar years, T. Rowe Price Real Estate returned an annualized average of 11 percent, but the average investor’s return, as calculated by Morningstar Inc., was a loss of 4 percent per annum.

Ouch.

That’s a disconnect of 15 percentage points; only eight stock funds that have been around for a decade have a bigger discrepancy.

Morningstar’s "investor returns" are designed to track a fund’s dollar-weighted performance, to see if money only moves into or out of a fund at the wrong times. Ideally, investor return would track the fund’s gains closely, meaning that investors rode it out with the fund through all conditions.

Obviously, that’s not happening with T. Rowe Price Real Estate, and the phenomenon is too big to ignore. If other average investors can’t make the fund work to their advantage — if they can’t stomach the ride — then new investors need to consider whether they can be smarter than those other guys, or if they are just being the next fool to rush in.

TOP-RANKED FUND

Make no mistake about it, the fund seemingly has everything going for it. Over the last 10 years, the annual return ranks in the top 20 percent of its Morningstar peer group, and Morningstar’s analysts like it so much they made the fund an "analyst’s pick," a status typically reserved for funds those analysts would bet on for the long haul with their own money. Lipper gives the fund its top mark for consistent return and expenses, and has it above average on total return; the fund’s expenses are well below its peers.

David Lee has managed the fund since its inception, and his record is impeccable. Over the last 10 full calendar years, TRREX only had three years in which it was a below-average performer. While the losses were big in 2007 and 2008, those were years that made a lot of funds and managers look silly.

"The hot subject matter among advisers is alternatives, finding assets that are not correlated with stocks and bonds and, historically, the purpose of real-estate funds was to be the non-correlated portion of a portfolio," said Jeff Tjornehoj, senior research analyst for Lipper.

"This looks like the kind of fund you would want to own to diversify your portfolio, but people need to realize that non-correlated assets doesn’t mean non-risky assets."

Lipper, too, has one key criticism of the fund, because it gives T. Rowe Price Real Estate its worst possible mark for "preservation of capital." It’s hard to believe a fund that generates consistent and good total returns can’t preserve capital, but Tjornehoj said that is the risk factor rearing up.

By all appearances, the fund has had some significant volatility on its way to a solid long-term trend. Investors, apparently, have been victimized by that volatility, buying in only after the run-ups and taking the brunt of the downturns.

T. Rowe Price would not discuss the fund with me, but the firm’s published numbers and those of the analysts don’t appear to show wild swings in assets under management, with investors fleeing or flocking in depending on the prevailing winds. Clearly, if you read anything T. Rowe Price sends to shareholders (and I do because I own other Price funds among my retirement holdings), the firm encourages long-term, stay-put investing.

That may mean that what appears to make T. Rowe Price Real Estate a bad bet is that other investors were dumb, and were chasing hot short-term performance rather than trying to hold a chunk of assets in real estate for the long haul. The problem could be less about the fund than about the people who have owned it.

If that is the case, an investor with a strong will and a strong stomach might be able to make the fund work.